We are living in unique times. There are a range of issues that make investing in this environment very challenging. This market is the most uncertain I have seen since the start of Covid. For good reason too. With inflation at 7% in the US, the Federal Reserve will likely start increasing interest rates from next month. Some institutions are now forecasting up to 7 interest rate increases this year. We also have geopolitical tensions as the prospect of conflict between Russia and the Ukraine intensifies. Not to mention the significant ongoing effects globally of the covid pandemic. After a big drop in January, markets have settled somewhat, but I would be extremely surprised if this is the end of the volatility.
In the very short term, there are real headwinds for markets, and I believe the change in monetary policy after 15 years of low rates is still being digested by markets. Wages growth due to labour shortages is now resulting in big jumps in salaries and will continue to put even more pressure on inflation and in turn interest rates in the short term. Even if inflation is transitory, interest rates will settle higher than they are currently. So, if the data from the US doesn’t show easing inflation soon then the volatility of January will likely be revisited at some point in the next couple of months.
Usually, when a market falls sharply you are rewarded by buying the dip. But the current situation the world faces isn’t a normal dip simply occurring because of a lack of confidence and over selling. We are seeing a fundamental shift in the rules of the game. Inflation is going higher at the moment and interest rates are poised to do the same. We are at an inflection point. It makes markets volatile as investors adjust rapidly to new information that either confirms or changes their view on inflation and interest rates. This is a market that will reward those who are patient over those who are bold and rush in.
However, from a long-term perspective, I am not concerned. If any of the current headwinds eventuate, there is very little I would do differently with regards to the specific stocks we invest in. We buy shares in great companies. So, regardless of short-term concerns, we will still hold stocks like Microsoft and Amazon in our client portfolios for the long term. The types of companies you want to own at the core of your portfolio are those that are great businesses, market leaders with great products and services and reliable earnings. Businesses that can easily scale but cannot be easily replicated and importantly have pricing power.
When a business has a unique product or service it can increase its prices and customers will stay. A good example is McDonalds who late last year passed on price increases of 6% in the US without missing a beat. Think of a company that could increase its prices by 10% and you’d still buy its product or service. That’s the hallmark of a great company, and it allows them to sustain their growth. This is especially important in times of rising inflation because the company can increase its prices to pass on costs and customers will pay the higher prices. So regardless of short-term trials and tribulations, companies with these attributes will do well over the long term in any economic environment.
It is said that time in the market, not timing the market is what matters most for long term investors. While that is broadly true the one situation that I have seen timing matter more than any other is investing a lump sum of cash in a volatile or sharply falling market. For existing portfolios, we hold more cash than usual, sure. It does make it more difficult for investors investing an overweight cash position into stocks. This is especially the case for those setting up a new portfolio or who have sold a business and have new cash to invest. But patience is key and over time opportunities to buy into core positions progressively will emerge.
I am as optimistic about the future as anyone. I am very bullish on the prospects of the share market over the long term and there are some fantastic companies out there that will do very well over time. That said I am cautious in the very short term. I don’t believe that the net result of 15 years of low interest rates coming to an end is a 3 week drop in January that recovers in February. That doesn’t make sense to me. The higher interest rates coming change the mathematics that underpins asset valuations, and the higher costs will impact everyone’s bottom line. I think cash is king for now and I am investing it slowly, progressively, and selectively adding to our high conviction stocks. Sometimes the most important part of managing money is protecting the downside risk at the expense of potentially higher returns.
General Advice Disclaimer: This information is of a general nature only and may not be relevant to your particular circumstances. The circumstances of each investor are different, and you should seek advice from an investment adviser who can consider if the strategies and products are right for you. Historical performance is often not a reliable indicator of future performance. You should not rely solely on historical performance to make investment decisions.